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Given geopolitical events in the Middle East, the U.S. dollar has every reason to rise in the foreign exchange market. But after the initial rise until March 20, it quickly returned to a downtrend and showed no technical signs of a bullish reversal. So why does it look so weak amid current systemic geopolitical risks and market expectations that the Fed won’t cut interest rates in the long term?
The U.S. dollar has had all the ingredients for a rally in recent weeks. Against the backdrop of geopolitical tensions in the Middle East and the resurgence of U.S. inflation, the U.S. dollar should give full play to its safe-haven role. Especially since markets no longer expect the Federal Reserve to cut interest rates before the end of 2027, a factor that has traditionally supported the currency. However, after an initial rally that lasted until March 20, the dollar’s gains quickly faded and returned to levels close to where they started. While the environment appears supportive, the lack of upside momentum is a strong sign that there are deeper factors weighing on the dollar.
In fact, several macroeconomic factors offset this theoretical support. The market currently expects the U.S. economy to slow down, unemployment may rise, and growth momentum will decline. In addition, core inflation continues to slow, reducing pressure on the Federal Reserve to maintain tight monetary policy. Even if headline inflation rises due to oil, this inflation is considered “low quality” because it is caused by supply factors and does not sustainably support the currency. Against this background, real interest rates are expected to fall, thus mechanically weakening the dollar in the foreign exchange market.
The chart below shows the key fundamental factors weighing on the U.S. dollar and limiting its role as a safe-haven currency in the face of geopolitical risks.
In addition, there have been important changes in monetary policy. The market believes that interest rates have peaked, ending the main structural driver of the dollar’s rise in recent years. The potential for more accommodative policy by the Fed, as exemplified by Kevin Warsh’s appointment as Fed chairman, reinforces this dynamic. At the same time, there are growing concerns about U.S. public finances. Rising debt and widening budget deficits raise questions about long-term sustainability and have a negative impact on the dollar’s credibility. This situation means that the need for external financing is increasing, making the United States more dependent on foreign capital.
Finally, international flows and structural dynamics play an important role in this ongoing vulnerability. Capital is moving to other regions, particularly Europe and emerging markets, which are seen as more attractive in terms of valuations. Central banks are also diversifying their reserves and gradually reducing their reliance on the U.S. dollar. This comes within the framework of a broader trend towards reducing reliance on the US dollar, led in particular by China and the BRICS. Against this backdrop, even geopolitical risks are not enough to sustainably support the dollar.
Technically, despite the bullish momentum change on the weekly time frame, the US dollar has yet to confirm a bullish reversal signal similar to what occurred in spring 2018 and fall 2021. The U.S. Dollar Index (DXY) was unable to break above the key resistance level of 101/102, keeping it in a downtrend from late 2022. Its direction this year will depend on the Fed in the coming weeks.
The chart below shows the weekly Japanese candlestick for the USD against a basket of major currencies (DXY). The key resistance level of 101/102 has not been breached.
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